If you’re an entrepreneur, you should be familiar with the term “Angel Tax.” According to Section 56(2)(viib) of the Income Tax Act, startups in India are required to pay a specified tax amount. However, the 2019 Union Budget introduced some relaxations. To qualify for the angel tax exemption, certain conditions must be fulfilled. In the following sections, we will delve into what angel tax is, the details of its exemption, and other related information. Continue reading to find out more.
What is Angel Tax?
In India, the “angel tax” is a term used to describe the tax levied on the capital raised by unlisted companies through the issue of shares to investors, particularly angel investors, when the share price exceeds the fair market value of the shares. This tax is governed by Section 56(2)(viib) of the Income Tax Act, 1961.
The rationale behind the angel tax is to prevent money laundering, where black money is introduced into the financial system through inflated share prices. However, it has been a contentious issue, particularly among startups and angel investors, as it can create a financial burden on genuine investments intended to support and grow new businesses.
Key points about angel tax:
- Applicability: It is usually applicable to unlisted companies.
- Valuation: The tax is levied when shares are issued at a price higher than the fair market value.
- Exemptions: Many jurisdictions, including India, have introduced certain exemptions or thresholds to mitigate the impact on startups and genuine investments.
- Criticism: It has faced criticism for being a hindrance to the startup ecosystem, as it discourages angel investments and imposes additional financial burdens on nascent companies.
Angel Tax Rate in India
Key Points:
- Rate: The Angel Tax rate is the applicable income tax rate, which is currently 30% (plus applicable cess 3%). The effective rate of the angel tax is 30.9%.
- Exemptions: As of recent updates, startups that are registered with the Department for Promotion of Industry and Internal Trade (DPIIT) and meet certain criteria are exempt from Angel Tax.
Example:
Let’s say a startup issues shares to an angel investor at a premium.
- Scenario:
- Fair Market Value (FMV) of shares: ₹100 per share
- Issue Price of shares: ₹150 per share
- Number of shares issued: 10,000
- Calculation:
- Amount received from investor: ₹150 * 10,000 = ₹1,500,000
- FMV of shares issued: ₹100 * 10,000 = ₹1,000,000
- Excess amount over FMV: ₹1,500,000 – ₹1,000,000 = ₹500,000
- Angel Tax:
- Taxable amount: ₹500,000
- Tax rate: 30%
- Tax to be paid: 30% of ₹500,000 = ₹150,000 (excluding surcharge and cess)
Changes and Updates:
To encourage startup investments, the government has made several amendments, including:
- Exemption for DPIIT-registered startups: Startups that are registered with DPIIT and meet certain criteria are exempt from Angel Tax.
- Thresholds and Limits: The government has periodically increased the limits and thresholds under which the Angel Tax does not apply.
This tax aims to curb money laundering through inflated share premiums but has faced criticism for potentially stifling genuine investments in startups. The exemptions and changes are part of efforts to strike a balance between preventing misuse and fostering a healthy startup ecosystem.
Budget 2024 Latest Update
In the Union Budget 2024, Finance Minister Nirmala Sitharaman announced the abolition of the angel tax, a move that has been widely welcomed by the startup community.
The angel tax, introduced in 2012 under Section 56(2)(viib) of the Income Tax Act, was imposed on investments made by unlisted companies through the issuance of shares at a price exceeding their fair market value. This tax, intended to curb money laundering, had become a significant hurdle for startups by imposing additional tax burdens and creating valuation disputes.
The removal of the angel tax is expected to foster a more supportive investment environment, encouraging both domestic and international investors to fund Indian startups. This change is aligned with the government’s Startup India initiative, aimed at promoting innovation and entrepreneurship across various sectors.
Angel Tax Exemption
Angel Tax Exemptions are provisions that allow eligible startups to be exempt from paying this tax under certain conditions. Key aspects of the exemptions include:
Angel Tax Exemption Conditions (as of 2019)
- DPIIT Recognition:
- The startup must be recognized by the Department for Promotion of Industry and Internal Trade (DPIIT).
- Paid-up Capital:
- The total paid-up capital of the startup should be less than or equal to ₹25 crores.
- The calculation of the paid-up capital excludes consideration received for shares issued to a non-resident, a venture capital fund, and a venture capital company.
- Valuation by Certified Merchant Valuer:
- A certified merchant valuer must assess and determine the fair market value of the startup.
- Investment Source:
- The startup must receive angel investments from foreign investors and not resident investors.
- Restriction on Use of Funds:
- The startup should not invest in any of the following within 7 years of issuing the shares:
- Building or land (other than those used for business operations).
- Advancing loans.
- Capital contribution to any other entity.
- Any mode of transport costing more than ₹10 lakhs, except for those used in the ordinary course of business.
- Jewellery.
- Archaeological collections.
- Shares and securities.
- The startup should not invest in any of the following within 7 years of issuing the shares:
These conditions were put in place to ensure that startups genuinely use the funds for their business growth and not for other purposes, thus providing a more transparent and supportive environment for startup investment.
Frequently Asked Questions
1. What is Angel Tax?
Angel tax is a tax imposed on the premium received by a startup from investors on the issue of shares, which is higher than the fair market value of those shares.
2. Who is Affected by Angel Tax?
Startups and investors involved in the issuance and acquisition of shares can be affected. The tax applies if the startup issues shares at a premium that exceeds the fair market value.
3. What is the Purpose of Angel Tax?
The main purpose is to prevent the misuse of funds and to avoid money laundering by ensuring that the funds received by startups are not from unexplained sources.
4. What is Fair Market Value (FMV)?
FMV is the price at which shares of a startup are considered to be traded in an open market. It is typically determined based on financial projections, asset valuations, and other relevant factors.
5. How is Angel Tax Calculated?
The angel tax is calculated on the difference between the share price paid by the investor and the FMV of the shares. This difference is taxed as income under the head “Income from Other Sources.”
6. Are There Any Exemptions?
Yes, certain exemptions and reliefs are available. Startups recognized by the Department for Promotion of Industry and Internal Trade (DPIIT) can apply for exemptions. There are also provisions under sections 56(2)(viib) and 54GB of the Income Tax Act, which may offer some relief.
7. How Can Startups Avoid Angel Tax?
- DPIIT Recognition: Obtain recognition from the DPIIT as a startup.
- Fair Valuation: Ensure that the valuation of shares is determined as per applicable rules and regulations.
- Documentation: Maintain proper documentation of investments and valuations to support the fair market value.
8. What Happens if Angel Tax is Imposed?
If angel tax is imposed, the startup will be liable to pay tax on the excess share premium. Additionally, the startup may face penalties or legal issues if they fail to comply with tax regulations.
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